8 steps to find the perfect personal loan

Annie Shaw,

Anyone considering taking out a fixed-rate personal loan is well advised to move fast.
The Bank of England has been dropping broad hints that it might have to raise interest rates to stop inflation exceeding its 2% target in the coming months.
Between March and April, the Consumer Prices Index nudged up by 0.6% - its highest monthly increase since May 2001 - and pushed the annual rate of inflation up from 1.8% to 2%.
And this has prompted economists to widely predict that rates will rise from their current 4.5 per cent level when the Bank’s rate-setting monetary policy committee meets early next month.
So, if you think you might be needing some extra cash, now could be a good time to do your homework and check what's on offer in the way of personal loans.
That way, you can lock yourself into one of the better deals still on the market before rates change.
So how do you know you are getting a good deal?
Follow our eight-point plan to finding the best personal loan.
1. Shop around
This may seem obvious, but it is amazing how many people just go to the bank where they have their current account. While it makes sense to see what your own bank has on offer - not least because it could save time on form filling and ID checks - you can save hundreds of pounds by taking out a best-buy loan rather than just plumping for the first one you are offered.
As many as 13 lenders, including Northern Rock, AA, cahoot and Moneyback Bank (part of Alliance & Leicester) have personal loans at less than 6% - thats four times more lenders in that market space than there were 12 months ago - but none of the best deals come from the big banks.
Your own bank may be the best option if there are any adverse items on your credit record, as your bank knows you and your credit history, and can give your application special consideration.
However, if yours is a straightforward case, make sure you choose from a wide range.
2. Don't just look at headline rates
While some lenders, such as Nationwide, offer a flat rate to all their customers, as many as 80% of personal loan lenders use "risk-based pricing" and will offer you a rate dependent on your credit history.
The rate quoted as "typical" in the advertisement may seem seductive, but it may not be the rate you end up with. Before you accept the offer of a loan make sure you know exactly what you will be paying.
Andrew Hagger, of data provider Moneyfacts, says: "As if shopping around for a personal loan is not complicated enough, with varying terms, conditions and rates, consumers should also be aware they may not receive the headline rate that may have initially attracted them.
"For consumers to know the rate they will pay, a credit application must first be processed. So, for those chasing the best rate available, the market has become much less transparent."
Illustrations for loans may be demonstrated in different ways - for instance, by the annual percentage rate (APR), with or without payment protection insurance included, by the monthly sum repayable, or by total amount paid.
Always compare like with like. The best way to compare loans for good value is to look at the total amount that you will repay over the whole loan period.
Best buys for loans of £5,000 over three years (without insurance) include Moneyback Bank at 5.5%, Direct Line at 5.6%, Masterloan and Northern Rock at 5.7%, and Lombard Direct at 5.8%. Some of the APRs are dependent on credit rating.
Best buys for £10,000 over five years (without insurance) include Moneyback Bank at 5.5%, Direct Line at 5.6%, Northern Rock at 5.7%, Lombard Direct at 5.8%, and Alliance & Leicester and Masterloan at 5.9%.
3. Think about the repayment period
Remember that if you borrow £10,000 and pay it back over 10 years you will pay more in total interest than if you pay it back over five years, because you are borrowing for a longer period. Your monthly payments will be less (and you may need the longer period to make the payments affordable) but you will pay more in the long run.
If you are borrowing to buy something with a short life, such as a holiday or even a second-hand car, do you really want to be paying for it for the next five or ten years, when your purchase is a distant memory?
4. Compare prices for larger and smaller loans
Astonishingly, the amount of money you borrow could influence the interest rate you pay, because most personal loan providers operate a tiered pricing structure, offering lower rates for large advances.
This is not a licence to splash out, but borrowing a few pounds more could actually save you money
For example, borrowers looking for a loan between £1,000 and £2,999 from Marks & Spencer Money would be quoted a typical rate of 19.9%, whereas borrowers of over £10,000 would be quoted a typical rate of only 6.4% - almost two-thirds less.
Research demonstrates that borrowing just £1 extra could potentially save almost £540 in interest!
If a borrower applied for a £4,999 loan from a certain company, the APR would be a huge 14.90%. However, if the borrower took out a £5,000 loan from the same company, the interest rate would be just 7.90%, because the sum borrowed comes into the next interest tier.
Over 36 months a borrower with the £4,999 loan would pay back £6,148, while someone borrowing a £5,000 loan would pay back just £5,609, a saving of £539.
Lisa Taylor of Moneyfacts says: "As you would expect with such large rate variations, the difference between the individual loan tiers is also very visible, more noticeably around the £5,000 mark.
"Depending on the lender's exact personal loan amount requirements, it may be worth some consumers borrowing just that little bit extra to push them into the next tier."
5. Beware of redemption penalties
If you think there is any chance that you might want to repay your loan early - either because you might receive a windfall such as an inheritance or bonus, or because you want to move to another lender - make sure you understand all the small print about how much you will have to pay if you redeem your loan before the agreed date.
It is possible to get a loan with no repayment penalty, so if your deal does make a charge for redeeming early, make sure you understand what you are signing up to.
6. Check the small print
Make sure you understand all the terms of the loan - what happens if you default, for instance.
7. Don't take out unnecessary payment protection insurance
This rarely offers a good deal, and in truth protects the lender rather than you in the event of you becoming ill or losing your job, leaving you unable to repay the loan. Exclusions are rife, and even if you decide to take out this type of insurance, statistically you are unlikely to make a successful claim.
According to recent research, fewer than one in 20 policies results in a claim, and, of those that do, as many as 85% are unsuccessful.
If you feel you do need this type of insurance, shop around for an alternative "accident, sickness and unemployment" policy, as cover offered by the loan provider is rarely good value.
8. Tread carefully with consolidation loans
These can make sense in some circumstances - for instance, paying off expensive store cards by taking out a fixed rate loan at a lower interest rate.
However, beware of extending the repayment period, as you will end up paying more in total over the increased term.

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